The strategy approval decision: A Sharpe ratio indifference curve approach
نویسندگان
چکیده
The problem of capital allocation to a set of strategies could be partially avoided or at least greatly simplified with an appropriate strategy approval decision process. This paper proposes such procedure. We begin by splitting the capital allocation problem into two sequential stages: Strategy approval and portfolio optimization. Then we argue that the goal of the second stage is to beat a naïve benchmark, and the goal of the first stage is to identify which strategies improve the performance of such naïve benchmark. This is a sensible approach, as it does not leave all the work to the optimizer, thus adding robustness to the final outcome. We introduce the concept of Sharpe ratio Indifference Curve, which represents the space of pairs (candidate strategy’s Sharpe ratio, candidate strategy’s correlation to the approved set) for which the Sharpe ratio of the expanded approved set remains constant. Thus, selecting strategies (or portfolio managers) solely based on past Sharpe ratio will lead to suboptimal outcomes, particularly when we ignore the impact that these decisions will have on the average correlation of the portfolio. Our Strategy Approval theorem proves that, under certain circumstances, it is entirely possible for firms to improve their overall Sharpe ratio by hiring portfolio managers with negative expected performance. Finally, we show that these results have important practical business implications with respect to the way investment firms hire, layoff and structure payouts.
منابع مشابه
Comparison of Portfolios Formed by Use of Grid Strategy Model Based on New and Traditional Variables Performance With Sharpe and Treynor Measures (Evidence of IRAN Exchange)
In this research, performance of portfolios formed by use of grid strategy based on new variables (aggressive, indifference and defensive stocks) presented by Rahnamaye Roodposhti (1388), and traditional ones (growth, growth-value and value stocks), calculated with Sharpe and Treynor performance measures and tested by an Active portfolio management approach to identify the portfolios by perform...
متن کاملOutperformance Testing of a Dynamic Assets Portfolio Selection Supplemented with a Continuous Paths Levy Process
This study aims at getting a better performance for optimal stock portfolios by modeling stocks prices dynamics through a continuous paths Levy process. To this end, the share prices are simulated using a multi-dimensional geometric Brownian motion model. Then, we use the results to form the optimal portfolio by maximizing the Sharpe ratio and comparing the findings with the outputs of the conv...
متن کاملIndifferent Points in The Multicriteria Decision Making Problems (A Case Study of Suppliers’ Evaluation in Zanjan Province Gas Company)
Evaluating and selecting the right contractors can increase the chances of success of a project and the organization. Considering the intense competition faced by organizations today, proper cost management to enhance profitability and customer satisfaction has attracted a lot of attention. The evaluation of contractors is usually a process thatis based on various criteria.By the end of it, the...
متن کاملNonlinear Trading Models Through Sharpe Ratio Maximization
While many trading strategies are based on price prediction, traders in financial markets are typically interested in optimizing risk-adjusted performance such as the Sharpe Ratio, rather than the price predictions themselves. This paper introduces an approach which generates a nonlinear strategy that explicitly maximizes the Sharpe Ratio. It is expressed as a neural network model whose output ...
متن کاملذخیره در منابع من
با ذخیره ی این منبع در منابع من، دسترسی به آن را برای استفاده های بعدی آسان تر کنید
برای دانلود متن کامل این مقاله و بیش از 32 میلیون مقاله دیگر ابتدا ثبت نام کنید
ثبت ناماگر عضو سایت هستید لطفا وارد حساب کاربری خود شوید
ورودعنوان ژورنال:
- Algorithmic Finance
دوره 2 شماره
صفحات -
تاریخ انتشار 2013